Identity Crisis March 2000

By Neil Ende

Posted: 03/2000

Identity Crisis
Should You Be A Reseller Or Distributor?
By Neil S. Ende

In the telecom world, perhaps more than any other, a company’s regulatory status may be
determined as much by how the company describes itself as by how it operates.

Providers of voice-grade services often are regulated, while providers of
"enhanced services" may not be. Resellers often are regulated; distributors
generally are not.

Despite the enormous consequences these differences can have on the manner in which
telecommunications businesses are operated and on their profitability, very few such
businesses take the time to consider these issues when determining how they will describe
and operate their business.

Even more troubling, perhaps, is that many companies’ agreements fail to properly
reflect the manner in which they actually do business. So, before you step into the
regulatory abyss or enter into business relationships with your suppliers and customers,
it is critical to consider carefully how you describe your operations, why you operate in
the manner you’ve chosen and whether your business could operate in a way that would limit
your regulatory exposure or allow you to enter into other lines of business with a minimum
of cost and delay.

Defining Terms

Although the term "resale" has been the subject of endless debate in the
regulatory community for several decades, as a general matter, a reseller is an entity
that purchases a service or product from a supplier (usually a telecommunications
carrier), sets the price of that service or product, and sells it under its own name to
its customers.

The essential elements are a purchase and a sale under the reseller’s name. Resellers
are generally arbitrageurs. They take advantage of and make their profit from the spread
between the wholesale price obtained by purchasing at volume and the higher retail price
generally available to end-user customers. In most circumstances, the resale process is
regulated at the federal and state levels.

A distributor is differentiated from a reseller on each of these issues. Unlike a
reseller, a distributor does not "purchase" a service or product from a
supplier, nor does it "sell" that product under its own name.

In the telecommunications context, a distributor is an agent of the supplier
(telecommunications carrier), selling the carrier’s service or product at rates, terms and
conditions set by the supplier. The distributor makes its "profit" through a
commission the supplier pays for selling the supplier’s service or product.

Absent unusual circumstances, the distribution of telecommunications services and
products is not subject to regulation.

The reason for the difference between the regulatory treatment accorded resellers and
distributors is simple and a byproduct of the inherent distinction between the act of
resale and act of distribution.

Regulators are concerned with protecting "the public interest." In a
practical sense, this means regulators are concerned about the quality, price and
availability of telecommunications services to the residents of their state or the
citizens of the country.

In a number of states, regulators have relaxed their scrutiny over interexchange
services, concluding market forces, such as vigorous competition, provide adequate
protection against misbehavior. Where competition is not deemed to provide adequate
protection, regulators use a variety of devices, including certification and tariffing, to
ensure customers are not overcharged and that the terms and conditions of service are just
and reasonable.

By their nature, these regulatory devices are directed at the supplier and resellers of
the telecommunications services and products and not at the entities that distribute those
services and products. This is because suppliers and resellers set the rates, terms and
conditions under which the services and products are sold; distributors do not. Thus,
regulations requiring certification and/or tariffing are imposed on suppliers and
resellers and not on distributors.

Choosing Sides

So–how do you decide if you are or should be a reseller, subject to regulation, or a
distributor who is not?

Reseller Side. There is no question the advantages of being a reseller can be
significant. As a reseller, you purchase the services you require from one or more service
providers and sell those services to your customers in the manner you see fit. You can
have facilities, if you want, and you can deal with as many service providers as you wish.

The services are sold and billed under your name, and you set all rates, terms and
conditions applicable to the services. If you decide to sell the business, it is yours to
sell (assuming your supplier agreements are assignable), and it will have a reasonably
definable value based on the size and nature of your customer base.

However, it is important to know that the costs of being a reseller are also quite
significant. Control over the rates, terms and conditions of service comes at a
significant cost. You will need to obtain regulatory approvals at the state and federal
levels, and you will need to file multiple state and federal tariffs
(See "Reality Check: It May Be Time for a Regulatory Audit," PHONE+,
December 1999).

In addition to these up-front filing requirements, you will need to maintain the
completeness and accuracy of your tariffs to ensure they reflect the rates, terms and
conditions under which services are then being provided.

As a reseller, you also will be obligated to file periodic reports with the FCC and
with a myriad of state regulatory authorities. The fees and expenses associated with these
initial filings can run in excess to $50,000, and annual compliance costs can run up to
$20,000.

As a reseller, you also will need to establish and maintain the infrastructure
necessary to provide customer service, to bill your customers and to collect from them.

Although these services can be outsourced, it can be quite expensive to do so. As a
reseller, you will face the risks of bad debt and ever-present risks associated with your
day-to-day supplier relationships. These risks include billing disputes, rate changes,
quality of service issues, customer service obligations. (Some of these risks are
discussed in previous articles, such as "Unholy Contract: The Legacy and Abuse of the
Filed Rate Doctrine," PHONE+, May 1999 and "Carrier Contracts: A
Minefield of Avoidable Risk," PHONE+, August 1999.) In short, operating as a
reseller has substantial benefits and potential risks.

Distributor Side. Distributor arrangements have a different set of pluses and
minuses. A key benefit of the distribution arrangement is the cost of entry is normally
much lower. In most cases, a distributor can commence business without prior regulatory
approval.

As a general matter, a distributor’s cost of doing business is also much lower, because
it does not have to provide or outsource any of the underlying services or the billing or
associated therewith.

At the same time, and contrary to popular belief, there is not necessarily a difference
in the level of "profit" derived as a reseller versus a distributor. With proper
counsel, entities can structure distribution relationships where the
"commission" they are paid for selling the supplier’s service is similar in
amount to the wholesale/retail spread they would have earned as a reseller. Thus, in many
circumstances, it may be to your economic advantage to consider a properly structured
distribution arrangement rather than a resale arrangement.

The most critical difference between a resale arrangement and a distribution
arrangement is, in a distribution context, it is the supplier, not the distributor, who
"owns" the end-user customer.

This is particularly true in the context of 1+ services, where the end user normally
will be presubscribed to the supplier’s network. (It is less true in the context of debit
cards where there frequently is no direct relationship between the supplier and the
end-user customer.)

Thus, as a distributor, you normally will have neither a customer base nor other hard
assets to sell. The value of your business will be based on your distribution network and
your commission stream.

Moreover, as a distributor, you are dependent on the rates, terms and conditions set by
your supplier(s) and the competitiveness of the services available from those supplier(s).
These factors can make it more difficult to properly value the present and future value of
your assets and thus to obtain an appropriate sales price.

In short, there is no absolute answer as to whether it is better to be a reseller or a
distributor. In most cases, the answer depends on the marketplace you serve, the nature of
your expertise and your overall business strategy.

Whatever you decide, it is critical your agreements properly reflect the specifics of
your business arrangement–clearly distinguishing between resale and distribution–and you
operate in a manner consistent with those agreements. If you take these steps, you can
operate successfully as either a reseller or a distributor of telecommunications services.

Neil S. Ende is founder and partner in the Technology Law Group LLC, a
Washington-based telecommunications law firm. He can be reached at +1 202 895 1707 or by
e-mail at [email protected].